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As it turns out, the terrifying omen came a day before Friday the 13th. Late last week, investors already anxious over rising unemployment, anemic growth levels, and mounting debt balances in the developed world were given one more reason be gloomy about the economic climate. When the technical indicator known as the ‘Hindenburg Omen’ was sighted late last week, many began to brace for a steep equity market sell-off.

The Hindenburg Omen is a series of technical indicators which when combined generally predict that a downward market correction is imminent. While not perfect by any means, the Omen has appeared before all of the stock market crashes or panics of the last 25 years in which the market dropped by more than 15%. The traditional definition of this phenomenon requires that each of the following five conditions are satisfied at the end of a trading day:

  1. The daily number of NYSE new 52 Week highs and the daily number of new 52 Week lows must both be greater than 69.
  2. The daily number of NYSE new 52 Week highs and the daily number of new 52 Week lows must both be greater than 2.2 percent of total NYSE issues traded that day.
  3. The NYSE 10 Week moving average is rising.
  4. The McClellan Oscillator is negative (suggesting that money is being taken out of the market).
  5. New 52 week highs cannot be more than twice the new 52 week lows.

All of these trends combine to show that the market is having great difficulty finding direction and is being tugged both up and down. When a substantial number of equities are falling, this could signal a bottom for the market while a large number of equities hitting new highs could suggest a bull market. However, many believe that both should not happen at the same time, saying that this scenario indicates the market is undergoing a period of extreme divergence — many stocks establishing new highs and many setting new lows as well. Such divergence is not usually conducive to future rising prices writes Peter Eliades on what he believes a wild market means for the near future. “A healthy market requires some semblance of internal uniformity, and it doesn’t matter what direction that uniformity takes.”

Before investors realize that this scenario perfectly describes the current market and run to sell off their holdings, it is important to remember that one reading doesn’t mean anything to most chartists who use this indicator. In order to be a true predictor, investors believe that the omen’s conditions must be met twice in a 36 day period, which leaves roughly one month for a ‘confirmed’ Hindenburg Omen to take place. Should this event take place researchers at safehaven.com found that based on the previous 27 confirmed Hindenburg Omen readings:

There is a 30 percent probability that a stock market crash — the big one — will occur after we get a confirmed (more than one in a cluster) Hindenburg Omen. There is a 40.8 percent probability that at least a panic sell-off will occur. There is a 55.6 percent probability that a sharp decline greater than 8.0 % will occur, and there is a 77.8 percent probability that a stock market decline of at least 5 percent will occur. Only one out of roughly 13 times will this signal fail.

Not everyone is sold on the Hindenburg Omen as a legitimate predictor of equity market instability. “Personally it sounds like [people] are starting their weekend drinking early,” said Guggenheim Securities managing director Andrew Brenner to the Wall Street Journal. Many analysts have indicated that the Hindenburg Omen is often a false alarm–only about 25% of Omen appearances have led to stock market declines that can be considered true “crashes.”

But for those who buy into the doom and gloom predictions made by Hindenburg proponents, we highlight three ETF ideas that may offer some protection should the market suddenly go into a tailspin:

  • SPDR Gold Trust (NYSEARCA:GLD): Generally speaking, as investors become fearful they tend to buy up precious metals and other safe haven assets that are known for their ability to maintain their value in turbulent market conditions. GLD represents the most liquid and widely held way to invest in gold bullion in ETF form; the fund has over $50 billion in assets under management and average volume exceeding 15 million shares a day.
  • iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX): If the market crashes, it is highly likely that volatility will increase as well (they don’t call the VIX the ‘fear index’ for nothing). The fund tracks the S&P 500 VIX Short-Term Futures Index Total Return, a benchmark that offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects the implied volatility of the S&P 500 Index at various points along the volatility forward curve. Although VXX is often vulnerable to return erosion from contangoed futures markets, it represents one of the few asset classes with a strong inverse relationship to equities.
  • iShares Barclays 20+ Year Treasury Bond Fund (NYSEARCA:TLT): A market crash could lead to a double dip recession and perhaps even a deflationary depression. Should this happen, it would send many investors into the relative safety of long-term U.S. Treasury bonds which have a higher yield than their shorter-term counterparts. TLT tracks the Barclays Capital U.S. 20+ Year Treasury Bond Index, a benchmark that measures the performance of U.S. Treasury securities that have a remaining maturity of at least 20 years. TLT is one of the more liquid long-term bond ETFs available to investors; it has over $3.3 billion in assets and more than 6 million in average daily volume. The fund charges an expense ratio of just 15 basis points while paying out a 30-Day SEC Yield of 3.8%, suggesting that it could be a great low-cost option to protect against a sharp market crash.

Disclosure: No positions at time of writing.

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Source: Three ETFs to Protect Against a 'Hindenburg Omen' Sighting